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Commercial Lease Terms Worth Understanding

- San Diego Daily Transcript

Commercial leases are lengthy legal documents usually prepared by the party that has the most leverage in the transaction. Typically that party is the landlord, though tenants occupying substantial space sometimes dictate the terms of their lease.

However, the landlord often presents a form lease to the average commercial space tenant, which is scanned and signed without a single objection. This despite the fact that buried deep within the lease may be terms that are unfavorable or downright onerous to the tenant.

If you are leasing commercial space, it’s important to understand the terminology used in your lease. "Permitted use," for example, as defined in a commercial lease, has broad implications. From a tenant’s perspective, permitted use should be both specific and expansive. Ideally, a tenant’s permitted use should be general enough to cover any lawful retail use.

This is relevant if down the road the tenant needs to assign its lease to another party. Although a tenant will in all likelihood still require landlord consent to assign its lease, it may not need to obtain the landlord’s consent for the assignee’s proposed use of the premises.

A tenant should obtain explicit permission from the landlord to engage in its individual retail activities. Many tenants have special uses that require exceptions to standard lease terms. For example, some tenants store minimal amounts of hazardous materials on their premises (such as propane tanks in a supermarket) or offer a minimum amount of competing products or services (vis-a-vis their co-tenants), which are normally restricted by landlord’s exclusivity arrangements. If these activities are not expressly permitted in the lease, they could potentially trigger a default.

A tenant also should not be required to open for business or commence paying rent until certain conditions have been met by the landlord. These conditions vary depending on the maturity of the commercial space or shopping center being leased.

For a new center, it is advisable that before beginning to pay rent, a tenant require the completion of all infrastructure such as streets, driveways and parking, and also demand that a majority of the other tenants of the shopping center have opened for business. Practically speaking, a tenant will not generate much business if its customers cannot reach its store for a lack of accessibility and will attract fewer customers if the center appears to be empty.

In addition, a tenant should negotiate the ability to re-measure its premises following delivery of the premises by the landlord. In the event the actual gross square footage of the premises is less than the square footage noted in the lease, all rent and additional charges to be paid under the lease should be adjusted by the landlord accordingly. A few square feet can mean thousands of dollars in rent and common area charges over the life of the lease.

Another important factor for a tenant to consider is that landlords typically approve certain tenant improvements at the beginning of a lease. Usually after the initial improvements are made, a tenant will require landlord permission to make any other improvements or modifications. Whenever possible, a tenant should retain the ability to make nonstructural improvements consistent with the lease without the landlord’s consent.

A tenant should also negotiate the right to not have to remove its initial improvements or any other modifications approved by the landlord at the expiration or termination of the lease term. This could save tenants a lot of money in demo work and could potentially create value for the landlord.

Tenants should also recognize that improvement restrictions may include areas outside the premises. Most new retail stores, for example, stream music from a satellite dish or antenna into their premises. Any equipment that requires rooftop access or perforation is prohibited by standard leases. If a tenant foresees such a need, it should negotiate the right to install rooftop equipment upfront. Permission should be granted, provided it does not void the landlord’s roof warranty.

Finally, a tenant should closely examine parts of the lease agreement that include common area expenses or triple net charges. These are fees collectively shared by tenants to cover maintenance and insurance of common areas. Usually, a tenant’s pro-rata share of common area expenses is not capped, which means this figure could inflate significantly year to year.

It is also important to note that these expenses may increase proportionately if a co-tenant leaves the building or shopping center, as they are usually calculated based on occupancy.

In addition, certain items should be excluded from common area charges. A few of those items are: costs that are not in line with the prevailing market rates, depreciation of the shopping center or common areas, costs of enforcement of any other lease in the shopping center, costs of repairing latent defects in the original construction of the shopping center and real estate taxes.

The landlord should always provide a tenant with annual, itemized common area expense statements and the tenant should negotiate the right to audit the landlord’s books and records in order to substantiate common area expenses. There are many other terms that tenants should consider and discuss with their landlord before executing a commercial lease. Ideally, the parties to a lease should use the agreement to allocate risk and maximize their mutual benefit.